There is an enduring truth in small entrepreneurial ventures: the founder is invariably the best CEO for the business and his or her departure can significantly weaken performance.
There is a misconception that the entrepreneur should stand aside as the business starts to mature, replaced by a career manager who has more skill in stgeloping structures, managing a larger workforce, and implementing stronger governance.
That’s the theory. The reality is small ventures often struggle a few years after a long-serving founder retires as CEO. The business loses some passion and spark, and the entrepreneur’s ability to understand customers, communicate with them, and sell, is badly missed.
Car-parts information company Infomedia was an example. A cracking stock for years, it lost its way when co-founder Richard Graham first retired in 2004. After tumbling to 30 cents in 2010, Graham stepped back in as executive chairman to right the ship.
Like all good entrepreneurs, he reconnected with old clients, found new ones, refocused the business, and helped Infomedia regains its mojo. Graham retired again from executive duties in September 2013, moving on to non-executive chairman. Infomedia now trades at $1.25.
Another small venture, software services group DWS, saw the return of founder Danny Wallis in April 2015. Previously CEO for 22 years, Wallis took on the position again “for the foreseeable future”, replacing Lachlan Armstrong, who left to work in private equity.
DWS designs, stgelops, and manages software solutions for the private and public sectors. Wallis started it in 1991 and two years later it had four staff and $60,000 turnover. A decade or so later, DWS had 193 staff and annual revenue of $27.05 million. After listing on ASX in June 2006, it raced from a $1 issue price to a peak of $3.35 in late 2007.
Then the Global Financial Crisis struck. By 2009, DWS had tanked to 50 cents as the market feared lower corporate demand for information-technology projects. By mid-2013, DWS was back at $1.50, but has since drifted to 61 cents.
Chart 1: DWS
Like many software services providers, DWS faced sluggish demand from large corporates and government departments for new IT projects. A trading update in December 2014 announced a significant writedown from an investment in a joint venture with a Canadian software company and downgraded earnings guidance for the first half of 2014-15.
DWS further disappointed the market with its interim result in February. Revenue fell 2 per cent because of subdued trading conditions, and reported net earnings dropped 24 per cent to $5.1 million. The interim dividend fell to 3.75 cents from 4.5 cents a year earlier.
The company said trading conditions were likely to remain subdued for the rest of 2014-2015, and said staff-utilisation rates in January and February were lower than expected because of delayed project starts. Finding positives in the half-year report was hard work.
Armstrong’s surprise resignation in April, after a year in the top job, and news in May of the conclusion of a 10-year E-tax project for the Australian Taxation Office, which affects about 4 per cent of DWS revenue, capped a tough start to calendar year 2015.
By early June, DWS was back at levels it last plumbed during the depth of the GFC.
That’s the bad news. The good news is Wallis has returned and board renewal is underway, with two independent non-executive directors, one of whom will be the new chairman, to be appointed.
He has a big job ahead. Global IT consulting firms continue to win market share, the rise of software-as-a-service providers is a fast-growing threat, profit margins are being compressed, and there is little to suggest a sudden pick-up in IT services demand in a sluggish economy.
Smaller Australian IT services companies arguably need to get bigger and stgelop more scale, to compete with multinational providers. Perhaps Wallis’s return as CEO clears the way for a merger or acquisition with another IT services companies, to provide greater clout to participate in and win large project tenders.
For all its challenges, DWS is debt free, had $16.4 million in cash on the balance sheet in the first half of 2014-15, and has been able to pay regular, fully franked dividends, although lower dividends per share are likely in the next few years.
It has reasonable scope to create greater scale through mergers or acquisitions and Wallis’ return has coincided with the acquisition in June of Symplicit, a user-experience digital design and innovation consultancy. It looks like a good deal.
The key question, of course, is how much of the subdued outlook is already reflected in the share price. At 61 cents, DWS trades on a prospective Price Earnings (PE) multiple of 7.6 times 2014-15 earnings, down from 12.6 times two years earlier, based on a consensus of a handful of analysts forecasts.
Morningstar has a hold recommendation and fair value of 62 cents a share. The stock valuation service Skaffold calculates DWS’ intrinsic value at 80 cents in two years, rising to 91 cents a year later. Five broking firms that cover the stock have hold recommendations.
My sense is there will be more bad news to come before DWS lifts and it may retest previous price support on its long-term chart around 50 cents. But it’s always worth watching when the long-serving founder returns to executive duties to inject more dynamism back into the organisation, reconnect with customers and investors, and protect his or her wealth.
As an $80 million micro-cap company, DWS suits experienced investors.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at June 17, 2015.